U.S. Dollar Gets Boost in Forex Trading from Fed Discount Rate Hike

The U.S. dollar got quite the boost in overnight forex trading after the Federal Reserve announced that it is hiking the discount rate by 25 basis points. By now, things have calmed down a bit, with the euro stabilizing and taking back its losses, but the U.K. pound is still struggling in currency trading against the greenback, and the dollar is up against the Japanese yen.

There had been some speculation before that the Fed could hike the discount rate as part of an economic stimulus exit strategy designed to limit inflation, but almost no one expected such a monetary policy move to come so soon.

GFT's Kathy Lien offers a look in FX360 at the difference between the discount rate and the Fed Funds rate:

First, it is important to realize that the discount rate is different from the Federal Funds or overnight lending rate. The discount rate is the rate charged to commercial banks and other depository institutions on loans that they receive from the Fed while the Fed funds rate is the rate that banks charge each other for loans. By hiking the discount rate and not the Fed funds rate, the central bank has in essence, widened the spread. The Fed also shortened the terms of primary loans to overnight from 90 days.

It will be interesting to see whether this move works, and whether banks start lending to each other. And, of course, it remains to be seen whether Ben Bernanke and the Fed got the timing right.